Bitcoin 101: Beware the geeks bearing digital coins

What is the blockchain revolution?

What is the blockchain revolution?

VideoFinance News Presenter Meilin Chew explains what blockchain can do and why it is gaining recognition in the financial world.

What do you get if you combine all the technological geekiness in the world into one ethereal thing?

Bitcoin, the fastest growing “asset” bubble the world has seen.

The world’s best-known digital currency is a complex combination of software coding, maths, cryptography and plain old accounting that when crunched by a computer leads to a finite number of winning outcomes.

The thing is, however, that bitcoins are still simply “bits” of digital information protected by complex layers of digital security stored on a worldwide computer network.

That’s not much different from most non-physical “money” held by banks.

What’s driving feverish speculation in bitcoins is that there will only ever be 21 million bitcoins “mined” into existence, unlike the seemingly never-ending supply of credit-money that banks create each and every day around the world with new loans.

Bitcoin mania is simply about betting how far the price can run before the speculative bubble bursts, probably when massive fraud is eventually perpetrated.

There are about 16.7 million bitcoins and, at yesterday’s record price of $US17,027 each, the total value is about $US285 billion, or the total size of Singapore’s economy.

Bitcoins were designed by a still anonymous person known as Satoshi Nakamoto, and they came into existence in 2009 just after the world was brought to its knees by the global financial crisis.

The original attraction to bitcoin was that they were a way to rebel against a finance-dominated world. They offered people distrustful of governments and banks another way to store and trade their wealth, legally gained or not, outside the formal global banking system.

But now bitcoin mania is simply about betting how far the price can run before the speculative bubble bursts, probably when massive fraud is eventually perpetrated.

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Bitcoins are stored on a distributed global network of “trustworthy”, independently owned computers running a complex accounting-type ledger known as a “blockchain”.

Blockchains work by having bitcoin “miners” verify all “blocks” of transaction information, to prevent fraudulent transactions, before they can all be fully certified in the ledger.

In return for verifying the system, miners are rewarded with bitcoins.

Bitcoin miners around the world use immense computer power, estimated to be the same amount of energy as the whole of the Netherlands uses, to process the transactions.

Bitcoin owners have a digital security “key” which they must use when transacting and they can store them on a personal “wallet” on a phone or computer, or on a digital coin exchange.

Similarly, the formal banking system also uses a special digital-key payments system for inter-bank transactions, while bank clients use cards with digital chips and pins for transactions.

But a critical difference between crypto-currencies, such as bitcoin, and conventional currencies, such as the dollar, pound and yen, is that they are not secured by a nation state with a strong judicial system, police force and army to maintain law and order.

Bitcoin trade takes part in a netherworld, out of the reach of tax authorities, the police and divorced spouses, which suits many people, but mostly the dishonest.

Few experts are negative about the underlying code and mechanics of bitcoin’s actual blockchain structure, but many are concerned about the risks for fraud at various points in the process, including storing keys at exchanges.

If something goes wrong in a bitcoin transaction, there is absolutely no recourse to anyone.

Lose your bitcoin key and the money is gone for ever.

Even online there is no friendly bitcoin client-services person to help you verify whether you have as many coins as you claim because your name exists nowhere in the bitcoin blockchain.

If someone steals your key and then your bitcoins the Australian judicial system will be of almost no help because it has no means to trace anything in the system.

If hackers break into any of the 124 digital currency exchanges dotted around the world and steal keys, an exchange could be bankrupted with no central bank or government to bail it out. In 2014, the Mt Gox exchange in Japan handled 70 per cent of all bitcoin transactions but it collapsed when about 850,000 bitcoins valued at $US450 million went missing.

Bitcoins’ screaming success has spawned a whole new industry.

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More than 1300 other crypto-currencies are sold to speculators via “initial coin offerings” that US authorities have warned are ripe for fraud.

But the reins are tightening on bitcoin trade, with reports this week claiming Britain’s Treasury department had disclosed plans to regulate bitcoin because of concerns it was being used to launder money and dodge tax.

British authorities reportedly plan to bring bitcoin trading in line with anti-money laundering and counterterrorism legislation that governs other financial transactions.

The US, European and Australian governments are unlikely to be far behind.

As to its usefulness as a currency, they say you can buy a coffee, a car and even a few houses with bitcoins, but its volatility over the past weeks has prompted some companies to stop accepting bitcoins because the exchange risk has become extreme.